IT HAS been a wonderful couple of weeks in shares for the well-diversified. The big markets have corkscrewed back up after a bloodbath start to the year. Portfolios and KiwiSavers straight across the country are looking a little brighter and the sighs of relief can be heard from Takapuna to Taumaranui. Diversification, as it did this time, will continue to save you over and over again.
Diversification isn't sexy or attractive, but it is still one of the most reliable golden rules of investing that we have. At a very technical level, boffins call it the "assigning of non-correlated assets" into a portfolio to "find optimal covariance" which will prevent mass destruction of the whole thing if events turn a bit tragic with some of the individual stocks. Put simply: never bet all your money on one horse, and if you have lots of horses, then don't stick 'em in one stable. When you spread your portfolio across numerous shares instead of a few, you lower the overall risk. The bumph shows that even without cherry-picking which shares you have but simply randomly assigning them from an index, this still holds true. Purists, (asset managers) will argue a little about that, with success in some cases I have to admit, and they'll tout Markowitz, efficient frontiers and non-systemic risk adjustment as the enhancers of higher returns. But even if we leave all that complicated stuff out and chose our shares by pinning a tail on a metaphorical market donkey, diversification cannot be beaten for risk reduction. Holding one company, no matter how much you believe it to be a diamond-encrusted sure thing, is infinitely more precarious than owning many of average breeding.
Given all this, why do some of the fanciest investment brains in the world do exactly the opposite? Jaws were on the floor this week with news out from Valeant Pharmaceuticals International. This is a drug company that, for a while, made tonnes of money buying up other drug companies and raising the prices of the acquired products. At its peak in 2015 Valeant traded at US$263. Hefty, masters of the universe type hedge funds waded in. Investment bankers call this "large portions" and it is a phrase that suggests a huge bet relative to all your other bets. A gamble that must be won, or you're toast.
Valeant's star twinkled and shined for a while. Television commentators declared it a magic jar of dollar bills with its double digit profit growth and the idea that everyone would pay high prices for drugs forever. It was all fun, all the time, and investors who had held from January 2012 until the high in August last year would have booked a capital gain on paper of 426 per cent. Then, cracks in the canvas. The acquisitions were stuffed to the eyeballs with debt, an "unusual financial relationship" with one of its partners and people, gasp, refusing to pay highly inflated sums for drugs.
Things got worse. Over the last seven months the price has been hammered down into the mid US$60s. Then last Tuesday it halved in value, closing at US$29. Complete default is possible. On that Tuesday some of the big boys with their giant stakes, already suffering fiercely, got torched. Valeant's largest holder lost US$1.6 billion ($2.3 billion). Known name Pershing Square dusted US$700 million. In one day. These sums are significant losses, even for these guys, on a stock that could do no wrong. So, to avoid a massacre of your money at the high altar of risk, just don't act like they did. Play the field and play it widely. Fingers in pies, heaps of them.
